Working Paper: CEPR ID: DP7753
Authors: Lutz Kilian; Dan Murphy
Abstract: We develop a structural model of the global market for crude oil that for the first time explicitly allows for shocks to the speculative demand for oil as well as shocks to the flow demand and flow supply. The forward-looking element of the real price of oil is identified with the help of data on oil inventories. The model estimates rule out explanations of the 2003-08 oil price surge based on unexpectedly diminishing oil supplies and based on speculative trading. Instead, we find that this surge was caused by fluctuations in the flow demand for oil driven by the global business cycle. There is evidence, however, that speculative demand shifts played an important role during earlier oil price shock episodes including 1979, 1986, and 1990. Recently, it has been suggested that it is possible for speculative trading to occur even without any change in oil inventories, if the short-run price elasticity of oil demand is zero. Our structural model allows us to obtain an estimate of this elasticity based on shifts of the supply curve along the demand curve. We show that, even after accounting for the role of inventories in smoothing oil consumption, our estimate of the price elasticity of oil demand is not close to zero and much higher than traditional estimates from dynamic models that do not account for price endogeneity. This eliminates speculation as an explanation of the 2003-08 oil price surge.
Keywords: demand fundamentals; gasoline demand elasticity; identification; inventories; oil demand elasticity; oil market; peak oil; speculation; structural model; supply
JEL Codes: D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fluctuations in flow demand driven by the global business cycle (F44) | surge in oil prices between 2003 and mid-2008 (Q31) |
| speculative demand shifts (E41) | earlier oil price shocks (e.g., in 1979, 1986, and 1990) (Q31) |
| short-run price elasticity of oil demand is much higher than traditional estimates (Q31) | estimates of oil demand elasticity (Q47) |
| coordinated oil supply cuts (L71) | recovery of the real price of oil starting in 1999 (Q31) |
| global demand shocks (F69) | major oil price shocks (Q43) |
| understanding the dynamics of oil inventories and the role of speculative demand (D84) | interpreting oil price fluctuations effectively (Q47) |